Am I leveraged too much?

Buying & Selling Real Estate
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Am I leveraged too much?

Matt Hendrickson
Investor · Kansas City, MO · Member since 2014 · 42 posts · 10 votes

I'm struggling to know when I'm ready to make my next move and purchase more real estate. I currently own two properties. It has been almost one year (August 1st) since I purchased my first property. I then purchased my second property in a tight cash flow/high appreciation area. My first property has brought me a 34% net return in year one. It has been extremely successful for me. I purchased the second property 7 months ago. Between the two properties I cash flow around $1,000 per month.

I've found another property that I feel confident will bring me a similar return as the first (same city, about 3 blocks away, similar price, similar SF, same Bedroom, more baths), but I'm not sure I should buy 3 properties within 1.1 years as it will make me leveraged to the tune of about $550,000. I have sufficient funds to purchase the property, but struggle with knowing whether or not I'm growing things too fast. Here is a quick snapshot into some of my situation:

  • $8,000 emergency fund for my two properties that I'm trying to grow to $15,000-$20,000
  • $25,000 in liquid-able assets aside from my emergency fund
  • To purchase this property I would need around $13,000

Please let me know your thoughts/experiences. I'm concerned I may be buying at a high point. The property is located in Utah which has seen strong economic growth in the past few years.

Thanks in advance!

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Dustin Beam
Kansas City, MO · Member since 2015 · 609 posts · 321 votes
8y

If I read it right, you have reasonable access to $33k for emergencies. Then you need to use $13k for the down payment. So $20k in reserves for 3 single family units, correct? 

That would not bother me too much personally. 

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  • Bryan Devitt
    Contractor · Oxford, MA · Member since 2018 · 807 posts · 745 votes
    8y

    Leverage is risk, risk is subjective. There is no right or wrong answer. IMO take the timeline out of your head, 3 weeks or 3 years of buying, the timeline doesn't matter. You're definitely tight on the emergency fund to say the least but what will this 3rd property cash flow? Is it already rented? Does it need repairs? I personally won't be buying anything until the crash happens and the bottom is found, but tons of other people think there is still a lot of room left for growth. No one knows, we're all just guessing and hoping for the best. If you're gut is telling you to go one way or the other, follow it.

    3Reply
  • Eric Adobo
    Member since 2018 · 509 posts · 211 votes
    8y

    A lot more info is needed. Ex. Total value of properties . Total income would be great to know.

    0Reply
  • Matt Hendrickson
    OP
    Investor · Kansas City, MO · Member since 2014 · 42 posts · 10 votes
    8y

    Bryan,

    Thanks for the response. I agree, part of my dilemma is the thought I could be buying at a peak.

    Eric:

    Property #1 Value: $220,000

    Property #2 Value: $215,000

    Right now, I've got a combined (with my wife) income of $100,000 +

    1Reply
  • Josh E.
    Rental Property Investor · UT (utah) · Member since 2016 · 48 posts · 59 votes
    8y
    @Matt Hendrickson How much rehab will you need to do on your current properties? I bought my first property in April of 2015, and knew I was going to need to replace the carpet in one of the units and paint. That went from a 5,000 budgeted rehab to 15,000 pretty quickly when we decided to do the whole property with LVP so as to last longer. Other things came up as well that were more than expected. At first I thought I would be fine with cash reserves of 12,000 or so and could cash flow the rest. Unfortunately, 2 other propertIes just happened to turn over at the exact same time, needed some work, and we were left in a bind. Luckily my wife and I also have good Income, so we were ok. Moral of the story is that things tend to hit you all at the same time, and tend to be more expensive than you budget. Just make sure you could weather the storm if it happened to hit next month. If you have a good enough deal, maybe teaming up with a partner could help?
    2Reply
  • Eric Adobo
    Member since 2018 · 509 posts · 211 votes
    8y

    Leveraged to the tune of $550,000. Meaning?

    Cash flow of $1,000 is great. But off what gross? 

    0Reply
  • Dustin Beam
    Kansas City, MO · Member since 2015 · 609 posts · 321 votes
    8y

    If I read it right, you have reasonable access to $33k for emergencies. Then you need to use $13k for the down payment. So $20k in reserves for 3 single family units, correct? 

    That would not bother me too much personally. 

    4Reply
  • Matt Hendrickson
    OP
    Investor · Kansas City, MO · Member since 2014 · 42 posts · 10 votes
    8y

    @Josh E. thanks for the response! Glad to see you're active on the BP community. How many properties do you have now? I am actually looking at teaming up if I were to do the deal. I've got a friend who is interested. I just can't decide if I should slow down and build up bigger cash reserves. I also still live in an apartment with my wife. I know she's going to be antsy to get into a house soon, so I've also thought about moving into a fourplex with her as well, but the returns have been very good so far.

    @Eric Adobo my current amount financed for the two properties is roughly $360,000. Gross rents are around $3,600

    1Reply
  • Eric Adobo
    Member since 2018 · 509 posts · 211 votes
    8y

    I think you are right on the line of being overleveraged. 

    If you have significant personal debt you are over the line. 

    1Reply
  • Kelly Iannone
    Rental Property Investor · Orlando, FL · Member since 2018 · 301 posts · 354 votes
    8y
    @Matt Hendrickson to each there own but times have been good for a while now and I’d except some market softness around the corner. Look at your rents and run scenarios for varying scale of market softness...can you still cover you expense? If so, then keep moving forward, if not then save more emergency, pay down some of the leverage to get yourself in a more comfortable position. This is my biggest grip with the leverage leverage leverage model.
    0Reply
  • George Pauley
    Chandler, AZ · Member since 2017 · 174 posts · 269 votes
    8y

    Interest rates are rising, which is putting the squeeze on finding profitable rentals.  So I think there is an argument for getting those properties in your portfolio while the getting is good.

    In general, I view leverage as a good thing. The more leverage I have (aka "using other peoples money") the greater the ROI on my investments. But there are caveats...

    First, I want fixed rate, non-ballooning mortgages.  I think a lot of folks got in trouble back in '08 because they had variable rates and balloons.  When credit dried up and property values decreased, those people were suddenly underwater and on their way to insolvency.  But if you are fixed rate, then the cost of the mortgage is the same no matter what happens in the real-estate or loan market.

    The second half of the equation is my renter's ability to continue to pay the rent.  I want rentals in markets where the economy is strong, and very likely to continue to be strong.  So market fundamentals are important.  I want to be sure my renters aren't going to lose their jobs and will be able to continue to pay the rent.

    If these two conditions are met, I don't really care how leveraged I am.  Actually that's not quite true.  If these conditions are met, I want to be as leveraged as possible!  :)

    (But, do make sure you have enough cash to make it through a soft spot.  Can you handle renters moving out of all of your properties simultaneously, taking 3 months to get new renters in, and having to do normal rehabs?)

    3Reply
  • David Zheng
    Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes
    8y

    Im basically leveraged up the wahoo currently but that's the price for expanding quickly  (32 units in 2.5 years)

    over $4 million in properties and 75% leveraged. only have $120k in reserves haha...

    rental income is at 65k/month so that does help mitigate some risk

    3Reply
  • Matt Hendrickson
    OP
    Investor · Kansas City, MO · Member since 2014 · 42 posts · 10 votes
    8y

    Thanks for the input. This is very helpful.

    @David Zheng is the 65k/month after subtracting out debt financing?

    0Reply
  • David Zheng
    Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes
    8y

    65k is my monthly rental revenue not including any debt coverage or expenses.

    0Reply
  • Peter M.
    Rental Property Investor · DFW, TX · Member since 2013 · 953 posts · 910 votes
    8y

    How are you financing a 220k investment property for 13k? My answer to your question though is: you should buy it, you are not over leveraged. If you can get 34% returns on and investment of 13k it seems like a no brainer but there are obviously other details that we don't know that you have probably taken into consideration.

    If you have fixed mortgages and you are cash flowing $1000 per month with the two you have, even if this one breaks even it seems like a good deal. If the crash happens and/or interest rates skyrocket, who cares? Your rental market would have to drop $333/unit per month for you to start having problems. I'm not saying it can't happen but it is very unlikely the bottom of the rental market would drop out like that unless they started giving houses to people. 

    Leverage is how you make your money grow faster. 

    3Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    8y

    @Matt Hendrickson I am fairly conservative financially and the numbers you have provided look reasonable, so I would go after the next property. 

    2Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    8y

    the more properties you have the less reserves per property you need and the safer each additional loan is. The old 100% occupied or 100% vacant with only one rental theory. 

    I consider myself very conservative but I bought two houses a year for 6 years (one as a rental and one as a new primary I lived in for a year.). My wife made about $90k/year but my only income was the rentals. We maxed out at $1.5mil in debt and have slowly worked it down to $1.1mil over the last 4 years by using all the rental income to pay off debt and increase cash flow. 

    For 12 properties I have about the same, maybe less reserves than you do. Eventually the cash flow can cover even a major repair. (Being Vegas these are newer houses with tile roofs and your mileage may vary. For me an expensive repair is $1,000 water heater or refrigerator, or a $2,000 air conditioner.

    I still kick myself for all the houses I didn’t buy and don’t regret any I did. I can see you 5 years down the road wi higher prices and higher interest rates wondering why you didn’t buy this one. 

    GL either way but I think you’re every safe. Heck, I bet there are families that make $100k/year living in $500k houses they don’t rent out. And you’ll have 3 rents coming in. 

    3Reply
  • Jim Walters
    Rental Property Investor · Conover, OH · Member since 2016 · 55 posts · 48 votes
    8y
    I would say the answer depends what your goals are If your goal is to get to 40 units in 5 years, then you will need to take on a lot of debt to get there. If you are happy where you are at now with the properties you have, then there is no need for the additional risk. If it was me I would take the risk as long as I was able to determine if the economy tanked for a year or two, I would still be able to be solevent. Good Luck!
    1Reply
  • Amanda Hillard
    Rental Property Investor · Tyler, TX · Member since 2018 · 32 posts · 23 votes
    8y
    @David Zheng my husband and I are in about the same place as you:) 65 doors in 5yrs roughly over $5mil in mortgages and growing. As long as the banks will continue to lend us to build our fourplexes we are forging ahead..we live in a stable area in Texas, we have 2FT employees, I still work FT as a nurse.. 10X rule;)
    2Reply
  • Victor S.
    WorldWide · Member since 2016 · 1k+ posts · 1k+ votes
    8y

    looks like you're roughly at 20% equity in your homes. will the new property keep your ratio steady? I, too, am interested how $13k gets you $200k in RE, while living in an apartment.

    0Reply
  • Joseph M.
    Flipper/Rehabber · Los Angeles, CA · Member since 2009 · 1k+ posts · 732 votes
    8y
    @Amanda Hillard That is interesting you are building 4plexes. What does it cost you to build them per square foot ?
    0Reply
  • Eric Adobo
    Member since 2018 · 509 posts · 211 votes
    8y

    The more properties the more absolute dollars you need in reserves. 

    If it's $5,000 per unit. Then 5 units require $25,000.

    Cheating a little is 👌. 

    0Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    8y

    @Amanda Hillard

    I too am interested in your fourplex building experience. 

    I’m considering build a small (4-8) fourplex community, selling a couple and keeping a couple. Are you building little fourplex neighborhoods or doing infill? What’s it costing per sf. How’d you find your builder? Are you selling or keeping them? You know, basic, give me all the info type questions. Sorry about that. But you’re doing something I’m interested in and not many people are. -thanks. 

    1Reply
  • Amanda Hillard
    Rental Property Investor · Tyler, TX · Member since 2018 · 32 posts · 23 votes
    8y
    @Joseph M. Well obviously my market is much different than you, mine being much lower priced than Cali..if we were to build for you here it would be $375-400k for the building. We build a very simple construction with 2-3br/2 baths and 2-2br/1bath; about 4500sqft total.
    2Reply
  • Amanda Hillard
    Rental Property Investor · Tyler, TX · Member since 2018 · 32 posts · 23 votes
    8y
    @Bill Brandt My husbands background is construction, so we build with 20% equity. We have never put money down until this last 16acres we just purchased to build 6-8 4plexes on..here cost to build for a customer would be $375-400k per 4plex, each 4500sqft, 2-3br/2bath and 2-2br/1bath.. we currently have 14 of them..and are 100% occupied, we normally have 1-2 open but typically fill very quick. I know that probably doesn’t answer all your questions but from our standpoint, we only do multi family, mobile homes and just a hand full of SF residences..we have never had a 4plex where every renter moved out at the same time, so relatively safe as far as that goes, much more than a SF that you cash flow is zero or neg when a tenant moves.
    3Reply
  • Bill B.
    Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
    8y

    @Amanda Hillard

    Thanks for the info. Now move to Vegas so I can buy some. :-). 

    I assume they are all identical. Did you draft up initial plans or go with a prepackaged plan like I see for sale on the internet?

    -thanks again. 

    0Reply
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